Tuesday, May 18, 2010

Robert Frank Responds to Me Responding to ...

[Robert Frank offers what will I think be the final post in our exchange. I agree with much of it, including his praise of the beauties of Ithaca. One of his points—that the rich can benefit from the existence of the poor—is one I already made in the post he is responding to. I do not think, however, that what he says here provides much support for the arguments of his NYT piece. Readers will have to decide for themselves whether they agree.]

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David’s thought experiment about the consequences of adding a million millionaires to an existing society promises to advance our discussion. I share his view that existing members of society would benefit from the presence of the new group in many important ways. But not in all ways.

The relevant issues are similar to those that bear on the question of whether someone with an annual income of $30,000 would be better off today than having that same real income in the United States 200 years ago. Someone with that salary back then would of course have been one of the richest members of society; but the same salary today would fall well below the median.

Some researchers have argued that once society’s absolute per-capita income rises beyond even a small fraction of today’s level, further economic growth does not increase well-being. On that view, it would clearly be better to earn $30,000 in 1810 than to earn the same amount today. But as I have argued elsewhere, absolute income gains confer many important advantages and will continue to do so, even if those advantages go unrecorded in conventional surveys of well-being. If you had a toothache, for example, or a child with bacterial pneumonia, you’d much rather have access to today’s remedies than to 1810’s. And many now-fatal illnesses will be someday be cured as a result of further income growth.

Even so, there are other aspects of life that most people would find more attractive on a $30,000 salary in 1810. If you wanted a house with a view, for instance, you’d be able to afford one, whereas such a house would be far beyond your reach today. More telling, relative income has always been an important factor in mate selection, as David acknowledges. If you were hoping to marry up, your chances would be much better on a $30,000 salary in 1810 than on that same salary today.

If I were making the choice, I’d find the attractions of living in today’s wealthier society sufficient to outweigh the disadvantages of having lower relative income. I’m confident that David would make the same choice. But that does not mean that having low relative income is without cost. And it certainly does not contradict my claim that having high relative income confers important instrumental advantages, quite apart from whatever purely psychological benefits might accompany high rank.

Contemporary examples of the issues we’ve been discussing are also on clear display in the lives of people in Upstate New York. Although most of this region is economically depressed, there remain isolated pockets of prosperity. Ithaca, where I have lived and worked for almost 40 years, is one. It has prospered largely because it is home to both Cornell University and Ithaca College. Other similarly situated small cities nearby are struggling from a steady decline of manufacturing employment over the past several decades. Unlike those cities, Ithaca has great public schools, a long list of good restaurants, a vibrant theater and music scene, and an abundant supply of well-maintained turn-of-the century houses. It also overlooks the scenic beauty of glacially carved Cayuga Lake and is surrounded by numerous parks with dramatic waterfalls and hiking trails. The incomes and other characteristics of the talented people attracted by Ithaca’s universities explain why the city’s built environment and cultural amenities dominate those of otherwise similar cities in the region. The choice between living in Ithaca or, say, a city like Utica, would be a no-brainer for someone like David or me.

But although the presence of people like us creates many tangible benefits for Ithaca’s low-income residents, it also imposes nontrivial costs on them. Because housing prices in Ithaca are so much higher than in other cities in the region, for example, Cornell’s maintenance staff typically find it difficult to find affordable living space anywhere near the city. Many endure daily commutes of 40 miles and more.

Again, this does not mean that Ithaca is a worse place for low-income people than Utica is. On the contrary, the fact that low-income residents here could have moved to Utica but chose not to suggests that they find the Ithaca environment more attractive on balance. But nor should we conclude that all low-income persons would find Ithaca’s environment compellingly more attractive. After all, there are many thousands of low-income people in the region who could have moved here yet chose not to. What is clear, in any event, is that low-income persons in Ithaca experience many costs that they would not have experienced in Utica. Those costs are mitigated in part, but only in part, by the fact that our local tax and expenditure systems are somewhat more progressive than those of other cities in the region. This strikes me as being a fair reflection of the benefits and burdens experienced by different income groups here.

David is also correct that there are enormous economies of scale and scope at the society level. On this point, it is instructive to consider a simple variant of his thought experiment—namely, to imagine a society consisting ONLY of a million millionaires. The wealthiest Americans today show little interest in laundering shirts, teaching seventh graders, fighting fires, stocking grocery shelves, collecting garbage, mowing lawns, or delivering packages. Who would perform these tasks in a society composed only of very wealthy members? The poor benefit from the rich, yes, but the rich also benefit from the poor in ways that transcend feelings about rank per se. In short, everyone benefits from social institutions that make membership in society attractive to as many people as possible.

Needless to say, the mere fact that larger societies generate a larger per-capita economic surplus does not eliminate disputes over how any given surplus should be divided. It is no surprise, then, that top earners often lobby against higher taxes while those who earn least lobby for higher transfers. But those self-interested claims should not prevent us from trying to understand the deeper functions of taxes and transfers.

Compelling evidence suggests that the implicit progressive tax observed in every private pay scheme helps enable heterogeneous work groups to form and remain stable. I have argued that the transfer schemes embedded in every tax system on the planet help foster social cohesion in a closely analogous way. In this sense, they are consistent with Ronald Coase’s observation that the best social institutions are those that most closely mimic the ones that well-informed individuals would have agreed to in the absence of transaction costs.

6 Comments:

"It is no surprise, then, that top earners often lobby against higher taxes while those who earn least lobby for higher transfers."

What an odd statement! Lobby? Really? You know people like this?

Assuming you meant prefer and not lobby, it's still an odd statement. What transfers are you talking about? Welfare programs are narrowly targeted. The one group that reliably benefits from government spending is not generally low income: government employees.

This contains a much better argument than Frank's previous posts. But it's an argument for Georgism, not income redistribution. Fencing off the commons, by e.g. occupying one of the few available building lots in a popular town, does impose a real negative externality on others. Simply doing better than them economically, per se, does not.

The problem with Mr. Frank's argument here is that he weakly acknowledges (but hardly refutes) one of David's main points. Namely: the 'relative status' external costs imposed by the wealthy on the poor exist only in a localised setting.

David's original response was to refute the claim that work place compensation in the private market justifies NATIONAL redistribution schemes. Libertarians in general have little problem with local political machinations which impose huge economic burdens on the productive. Why? Because living in these relatively small communities is voluntary. If wealth redistribution occurred only on a local level, most Libertarians would be quite happy. People would be free to weigh the relative costs and benefits associated with living in nicer, probably higher-taxed regions versus cheaper, less attractive areas. Rich people who value having a higher status over loosing monetary wealth would directly compensate those on whom they imposed their high-rank externalities: the poorer people who actually live in their region. Taxes and regional amenities would become competitive and specialise towards those with similar tastes.

Indeed, the example Mr Frank cites of Ithaca and Utica is quite unobjectionable. (Which is probably why he chose it.) The richer citizens of Ithaca weigh the higher tax burden against the amenities of the area and find it worth the cost. The poorer citizens weigh the benefit from the progressive taxes versus their costs and decide to stay. Those who come to the opposite conclusion leave.

The problem is that this situation has no logical comparison to a nation-wide redistributive tax. Rich persons who do not wish to impose any status externalities on the poor and would prefer to retain their wealth have no possible recourse. Even if a wealthy person decides to live modestly in a poorer area, he is still taxed a priori based on his economic success.

Near the end of a paragraph supposedly addressing this point, Mr. Frank says: "The poor benefit from the rich, yes, but the rich also benefit from the poor in ways that transcend feelings about rank per se. In short, everyone benefits from social institutions that make membership in society attractive to as many people as possible."This glib statement contains the heart of the contradiction in Mr. Frank's argument. His goal of "making society attractive to as many people as possible" stands in direct conflict with a nation-wide redistributive tax formula. A nation wide tax policy assumes a fixed rate of consumption of externality-causing status by the rich nation wide and imposes a fixed-rate nation wide progressive tax. But, as Mr. Frank noted, the cost-benefit relations between rich and poor are complex and dynamic. By the local nature of this interaction, implicitly, the relative costs and benefits derived by both classes varies widely depending on region. How, then, does a blanket national redistributive tax, which is immune to market pressure, regional variability and personal choice, fit the needs of even a minority of citizens? In this sense, they are not remotely consistent with Ronald Coase’s observation.

Your discussion of relative income ignores how that income is generated. In an efficient market-based system, high income should mostly come from creating things that other people value (allowing for some confusion). So a high-income person may impose costs on the rest of society, in making it more difficult for them to buy a nice view, but also provides benefits, eg an experienced cardiac surgeon who has a patient death-rate 30% lower than if the patients were treated by a non-specialist GP, is clearly providing benefits to society, not all of which are captured in her salary. Or, less vividly, but important nonetheless, the Beatles created lots of benefits to society, both directly through people who enjoyed their music and by providing common sources of discussion/obsession.

This isn't true of all sorts of income-generation, eg governments can easily pay large incomes or subsidies to people who don't benefit society very much. But then governments should stop paying said large incomes/subsidies, rather than play around taxing both those people and other people who do provide lots of value.

Compelling evidence suggests that the implicit progressive tax observed in every private pay scheme helps enable heterogeneous work groups to form and remain stable.

So highly-paid medical specialists can't form stable teams with, say, newly graduated nurses? Not that I have ever consciously sat in on a hospital operation, but this seems a bit implausible. I mean, I knew hospital shows on TV are inaccurate, but I didn't know that they were that inaccurate.